Tax-concerned parents want to avoid penalties

Q. We will cash U.S. Savings Bonds to cover college expenses. We do not qualify for the federal savings bond tax-free education program because of our combined incomes. How do we pay the tax? Should we increase our income tax deductions on our paychecks, or make a one-time payment to the IRS, or wait until we file our federal income taxes? We don’t want to be penalized for underpayment of taxes. – Tax Concerned Parent

A. Ah! The complex estimated tax payments challenge! The Brain is sort of surprised no reality-TV producer has come up with a show idea related to complicated tax math.

Kudos to you for thinking ahead and anticipating penalties and interest.

"The bond interest will be taxed as ordinary income, not at the capital gains tax rate," said Joe Leone, a certified financial planner and certified public accountant with Pinnacle Benefits Group in Manasquan. "The easiest way to account for the additional tax due is to increase your withholding at work."

Paying it at the end of the year is not advised because as you feared, you could end up owing an "under-withholding" penalty if enough tax was not paid during the year, Leone said.

The basic rule for paying taxes in the tax code is this: When you get your income, the IRS wants the taxes, said Clare Wherley, a certified financial planner and certified public accountant with Lassus Wherley in New Providence.

She said the simple answer to the question is that taxes are due in the period that you cash in the bonds. The next question would be: what are these periods?

Wherley said there are four payment periods for estimated tax liabilities:

• For income from Jan. 1 to March 31, estimated payments are due April 15.

• For income from April 1 to May 31, estimated payments are due June 15.

• For income from June 1 to Aug. 31, estimated payments are due Sept. 15.

• For income from Sept. 1 to Dec. 31, estimated payments are due Jan. 15 of the following year.

Wherley said if you cashed the bonds in August, the tax on the bonds is due Sept. 15.

But, Wherley said there are other considerations and you may not have to pay the estimated tax unless you expect to owe at least $1,000 in tax for the current year after considering your withholding and any credits, and, you expect your withholding and credits to be less than the smaller of 90 percent of the tax you will owe, or 100 percent of the tax you owed last year. Also, if you know the amount you will owe before April 15, you may divide the total into four equal parts and pay a fourth on each of the due dates. And finally, if your adjusted gross income is greater than $150,000, substitute 110 percent for the 100 percent mentioned previously.

"Don’t forget state taxes may also be due," Wherley said. "The payment periods are the same. For New Jersey, if the expected amount owed is greater than $400 and the expected withholding is less than the smaller of 80% of the total tax you will owe or 100% of the prior year’s tax, then estimated payments must be made.